As the major US averages grind to more new highs, I am seeing signs of confirmed upside breakouts everywhere. Consider, for example, this relative performance chart of SPY against IEF, which is the ETF for 10-year Treasuries. The ratio staged an upside breakout on the weekly chart, with relative resistance a some distance away indicating considerable upside potential for stocks.

Across the Atlantic, the FTSE 100 staged an upside breakout:

The same could be said of large cap eurozone stocks, as represented by the Euro STOXX 50:

The European markets are healing, as the WSJ reports even Greek companies are now tapping the bond markets for financing:

Greek commercial refrigeration and glass bottle producer Frigoglass’s debut bond sale is the latest sign investors are growing more optimistic about Greece, the company’s chief executive said in an interview with Dow Jones Newswires Tuesday.

Frigoglass Monday sold a €250 million ($324.3 million) five-year bond–the second debt sale from a Greek company in as many weeks as the country’s corporate bond market emerges from a deep freeze.

The risk-on mood was also reflected in this account of Slovenia’s successful bond financing, after Moody’s downgraded the country to junk after its roadshow:

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

Key risks
Though momentum is positive for stocks in most developed markets, it isn’t necessarily all clear sailing ahead. My biggest concern is that China and China related plays look punk. Here is the Shanghai Composite in a well defined downtrend:

Industrial commodities are also exhibiting a similar downtrend pattern:

The AUDCAD currency cross, where Australia is more China sensitive and Canada more US sensitive, looks downright ugly.

In the US, Ed Yardeni pointed out that forward Street consensus earnings growth is showing signs of stalling. While this isn’t a bearish signal yet, it does bear watching. Should forward estimates growth turn negative, it would create considerable headwinds for equities.

My takeaway from the current environment of powerful stock momentum is, “It’s ok to get long, but don’t forget to look over your shoulder and maintain a tight risk control discipline.”

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Despite Friday’s disappointing Non-Farm Payroll release, I remain relatively constructive on the stock market’s outlook for several reasons. First, the market sold off on the open, but rallied into the close – a positive sign.

Second, higher beta parts of the market have been outperforming in spite of the negative news. Consider this chart of the relative performance of small caps against the large caps indicating that the risk-on trade may not be done yet.

The risk-on rebound isn’t just confined to the United States. Here is the performance of Greece compared to Europe, which is a key measure of risk aversion:

Here is the relative performance of Italy:

You get the idea.

What about the defensive stock leadership?
The one cautionary sign that I had mentioned last week was the leadership of defensive sectors (see Something’s not right about this rally). I was not the only one to notice this effect. David Rosenberg mentioned it last Thursday and the WSJ featured a comment from UBS on the curious leadership behavior:

As the chart from UBS strategist Jonathan Golub shows, the classic defensive sectors, such as health care and consumer staples, led the way during the first three months of the year, while some of the more cyclical sectors, such as energy and tech, lagged near the bottom of the pack.

Defensive leadership or Value leadership?
There may be a more benign explanation for the leadership of defensive sectors. Value stocks have been outperforming Growth stocks since last June. The chart below of the relative performance of the Russell 1000 Value Index against the Russell 1000 Growth Index tells the story.

It just so happens that the Russell 1000 Value Index is overweight the kinds of sectors that have been outperforming, such as Financials and Utilities and the Russell 1000 Growth Index is overweight the sectors that have been lagging, such as the cyclically sensitive Industrials and Technology.

What’s more, leadership in Value isn’t just a sector effect. A contact of mine at MSCI Barra indicated to me that their factor analysis shows the performance of Value factors like Book to Price and Dividend yield to be outperforming as well. That outperformance was net of industry effects.

Bottom line: The upcoming Earnings Season will give us the best answer to the question of whether the real leadership is defensive stocks, which suggests caution, or Value stocks, which could be neutral to bullish.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Evidence suggests that the implementation of unconventional monetary policy during the recent financial crisis, via credit easing and asset purchases, succeeded in reducing credit spreads and yields, thereby providing further easing of financial and monetary conditions and fostering aggregate demand.

These policy measures are most effective when targeted to specific market failures, sufficiently large relative to the targeted market, and clearly communicated.

The evidence must be treated with appropriate caution, since the evaluation of the effectiveness of unconventional monetary policy is subject to problems of identification.

The ongoing fiscal retrenchment will affect the outlook and therefore the timing of the withdrawal of monetary stimulus.

Central banks should account for the potential negative externalities of unconventional monetary policies, which are often neglected in the analysis of their effectivness.

Dave Altig and John Robertson of the Atlanta Fed’s macroblog referenced the paper in a post and highlighted what they considered the salient points [emphasis theirs, not mine]:

The effectiveness of unconventional monetary policy measures depends on several factors. Measures appear to have been effective (i) when targeted to address a specific market failure, focusing on market segments that were important to the overall economy; (ii) when they were large in terms of total stock purchased relative to the size of the target market; and (iii) when enhanced by clear communication regarding the objectives of the facility

In other words, you need to adjust the size of the bazooka to the size of the market. If the Fed were to choose to start buying MBS securities, the size of the intervention needs to sufficiently large to push MBS prices up (and yields down). On the other hand, an extension of Operation Twist will likely have limited effect, other than on market psychology, because it only has a limited amount of short-dated securities it can sell in order to extend the maturity of its holdings. Altig and Roberson went on to say:

[T]he accumulated evidence suggests to us that we should be really thinking in terms of something like the stock or accumulated total of Fed purchases relative to the size of publicly held Treasury debt, as the passage from Kozicki and coauthors indicates. That calculation produces a Federal Reserve share of about 16 percent of publicly held Treasury securities for fiscal year 2011, which is up sharply from the 8–10 percent levels seen during the 2008–10 period but very similar to the share of Treasury securities held by the Federal Reserve during the years 2000 through 2007.

They went on to say that the Fed should also consider not how much Treasury securities the Fed holds, but the composition of the supply:

In the shorter term, changes in the magnitude of federal government may not have too large of an independent impact on the stance of monetary policy, although it is noteworthy that current projections indicate the Treasury will sell about $1,450 billion of debt to the public in fiscal year 2012, and $1,060 billion in 2013. In addition there is this, from today’s edition of The Wall Street Journal’s Real Time Economics:

“The U.S. Treasury intends to continue to gradually extend the average maturity of the securities it issues—a tactic that locks in borrowing costs but potentially dilutes the impact of a Federal Reserve policy intended to boost the economy.”

In such an environment, it is probably good to remember that standing pat with central bank asset purchases does not necessarily mean standing still with monetary policy.

Monday’s market reaction to the Greek election, where it more or less got what it wanted, is telling. The consensus seems to be for more Twist, but not much else (see one example here). Just keep this in mind as you assess the Fed’s announcement Wednesday.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

How the market reacts to news can be an important clue of future direction. In my last post, I wrote that you shouldn’t expect too much from the ECB or Fed this week. The European Central Bank certainly disappointed the bulls with their inaction, not only on interest rates, but on the prospects for “extraordinary measures”.

Now it’s Ben Bernanke’s turn.

We already have a clue on what Bernanke will say from Jon Hilsenrath’s WSJ article entitled Fed Considers More Action Amid New Recovery Doubts. Here is what I am watching for. Will the markets key on the comment that action is not likely in the June FOMC meeting?

The Fed’s next meeting, June 19 and 20, could be too soon for conclusive decisions. Fed policy makers have many unanswered questions and have had trouble forming a consensus in the past. Top Fed officials have said that they would support new measures if they became convinced the U.S. wasn’t making progress on bringing down unemployment. Recent disappointing employment reports have raised this possibility, but the data might be a temporary blip. Moreover, the Fed’s options for more easing are sure to stir internal resistance at the central bank if they are considered.

Or will the market key on the fact that the Fed is considering further quantitative easing [emphasis added]?

Their options include doing nothing and continuing to assess the economic outlook—or more strongly signaling a willingness to act later if the outlook more clearly worsens. Fed policy makers could take a small precautionary measure, like extending for a short period its “Operation Twist” program—in which the Fed is selling short-term securities and using the proceeds to buy long-term securities. Or, policy makers could take bolder action such as launching another large round of bond purchases if they become convinced of a significant slowdown.

What Hilsenrath wrote is not that different from what New York Fed President Dudley said in late May in the WSJ, that the Fed will act should it see signs of economic weakness:

Expectations for U.S. economic growth, while “pretty disappointing” at around 2.4%, is sufficient to keep the central bank from easing monetary policy, Federal Reserve Bank of New York President William Dudley said.

“My view is that, if we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front,” Dudley said in an interview with CNBC, aired Thursday.

Now that we know what Chairman Bernanke is likely to say, watch the market reaction. Is the QE glass half-full or half-empty?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Policy in Europe has generally been done in the back rooms, with the theatre, e.g. PIIGS debt re-negotiations, done in the front rooms. Last year, the markets were panicked because they perceived the backroom elites had lost control of the situation and events were spiraling out of control.

Today, it appears that the elites have calmed things down and there had always been a Grand Plan. We got hints of this when Angela Merkel said that there was no silver bullet to the eurozone crisis, but resolution was a “long process”.

Now ECB head Mario Draghi, in a WSJ interview, reveals the Grand Plan. Not only does he speak on monetary policy, I found it more important that he touched on fiscal policy and micro-economics, which is an indication that he was speaking about the European Grand Plan.

The Grand Plan involves austerity, but it’s not all austerity all the time. Draghi distinguishes between “good austerity” and “bad austerity”.

Draghi: In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.

WSJ: Bad austerity?

Draghi: The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth.

Lower taxes and less government expenditures? That sounds positively…Anglo-Saxon (excuse my French).

Draghi went on to say that the next step, after austerity, is structural reform “because the short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place”. Draghi went on to say [emphasis added]:

WSJ: Which do you think are the most important structural reforms?

Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.

In other words, union busting and going after all of the entrenched interests of the old with their lifetime jobs and gold-plated pensions at the expense of the young jobless. It sounds positively Thatcherite. Draghi went on to say that the old days of the European social model are gone [emphasis added]:

WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.

Mario Draghi is an important central banker and chooses his words carefully. I can’t believe that he would go rogue and speak so frankly about fiscal and other government policy outside the ECB’s mandate without the consent, or at least informing, the likes of Merkel and Sarkozy. So you have to believe that he is speaking on behalf of either the Elites or at least Merkozy in detailing this Grand Plan.

Can the Grand Plan work?
Today, I see commentary about how austerity is biting and the people of Greece (followed by Portugal) cannot possibly survive with a policy of all-austerity-all-the-time. They are missing the point. Draghi said that structural reforms must follow because “short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place.”

This sounds like a long and hard road. Can it succeed?

The plan sounds like it was written out of the Maggie Thatcher playbook. It is also somewhat Teutonic in that it is well aware of the link between competitiveness and productivity, as well as the remarkable German technique of achieving a consensus between business, labour and government.

I am cautiously optimistic that the Grand Plan could work, which would lead to a period of European Renaissance. For it to work, however, many things have to go right. First of all, you need all of the actors to fall into line and no one to quit because “enough is enough”. So watch the upcoming Greek elections and watch the upcoming French elections for how much support Marine Le Pen gets as important barometers of discontent on the Street. I remain optimistic because we are not at that breaking point because, despite the mass content with the bailout plan, the latest opinion polls of Greeks show that 77% want to stay in the eurozone “at all costs”.

WSJ: Would you be open to doing more, or longer, LTROs if needed?Draghi: You know how we answer these questions. We never pre-commit.

Also notice how the ECB’s LTRO program amounts to de facto quantitative easing and money printing, but there hasn’t been a single word of protest from the German hardliners? That’s an indication that there is a Grand Plan which the elites are executing.

The jury is out on the Grand Plan but if this all works, Merkel could be lionized as the new Thatcher and Draghi as the new Maestro.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Long time readers know that I am a long-term commodity bull. Moreover, I have been writing on the theme of global healing for a few weeks. Despite last week’s disappointing US GDP report, I am seeing signs that it may be time to get on the commodity bull for a ride. Both sentiment and momentum indicators are lining up for another upleg in commodity prices.

First of all, sentiment measures indicate that commodity prices are at levels suggesting accumulation. This chart from Mary Ann Bartels of BoA/Merrill Lynch (Note: the depictions of bull and bear phases are mine, not hers) shows that large speculators, who are mainly hedge funds, have moved off a crowded long in commodity prices. The chart was produced by aggregating the Commitment of Data reports for all futures exchange traded commodities in the CRB Index.

My depiction of the bull and bear phases show that during the bear phases, neutral readings are good times to fade the rally. On the other hand, neutral readings are good opportunity to accumulate positions during the bull phases. The bull and bear phases is best exemplified by the chart of the bellwether of gold prices, which bottomed in 2002 along with the rest of the commodity complex.

Just because there is a neutral signal from this is a good time to accumulate positions doesn’t mean that there isn’t more downside to commodity prices. To see some near-term upside, you need a catalyst.

We expect improving world economic growth to increase demand for commodities. Our outlook assumes most commodity prices will increase slightly in 2012 and continue at levels that encourage investment. We expect that copper will average over $4 per pound, Central Appalachian coal about $75 per ton and West Texas Intermediate crude oil about $100 per barrel.

In particular, mining will be a source of growth in 2012 and growth will be so high that supply will have a tough time with meeting demand:

We expect mining to continue to be strong globally, and we have a sizable order backlog for mining equipment. We expect sales to increase in 2012 and are in the process of adding production capacity for many of our mining products. However, we expect sales to be constrained by capacity throughout 2012.

Moreover, the WSJ showed that the American economy continues to grow despite last week’s disappointing GDP report:

CAT was bullish on the outlook for US housing:

We expect total U.S. construction spending, which, net of inflation, has declined since 2004, to finally begin to recover in 2012. We project a 1.5-percent increase in infrastructure-related construction and a 5-percent increase in nonresidential building construction. We are expecting housing starts of at least 700 thousand units in 2012, up from 607 thousand units in 2011.

They were sanguine on Europe because of ECB support of the eurozone:

The Eurozone public debt crisis has been a lingering negative, but it is unlikely to trigger a worldwide recession. The Eurozone will likely have at least two quarters of weak, possibly negative growth, but should begin to improve in the second half of 2012. For 2012, our outlook assumes economic growth for the Eurozone near zero and growth of about half of a percentage point for Europe in total.

Our expectation for improvement of European growth in the second half of 2012 rests on a continued easing by the European Central Bank (ECB). The ECB has recently lowered interest rates and could cut rates further in 2012.

CAT also saw sufficient growth in China to support construction demand and commodity growth:

China took its first easing action in late 2011, and we expect that further easing is likely. We expect China’s economy will grow 8.5 percent in 2012, sufficient for growth in construction and increased commodity demand.

In addition, Joe Weisenthal highlighted some of the positive long-term fundamental drivers of Chinese commodity demand, namely a population that is rapidly becoming more affluent, which will raise demand for the consumer good life, such as electricity:

…and autos:

So there you have it:

A long-term rising demand for commodity prices from emerging market countries like China;

A neutral to moderately bullish sentiment environment for commodity prices; and

A forward looking bullish outlook from a global company that is highly exposed to cyclical growth.

What more do you need?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

In the wake of the “beat” by the ADP release and as traders wait for the Non-Farm Payroll figures due out at 830 Eastern Time, here is something to ponder.

Is good news (better growth) good news or bad news?
The most recent string of economic releases have been pointing to an American economy that is growing, albeit slowly at a 1-2% real rate of growth. The WSJ reports that primary dealers are expecting that QE3 is on the way:

The primary dealers also see a 60% chance of the Fed adding to its System Open Market Account holdings — embarking on QE3, in other words — in the next two years. That also gibes generally with what many on Wall Street seem to expect.

In addition, Zero Hedge has reported that Deutsche Bank believes that the market has discounted $800b in QE3:

Analyzing historically the reaction function of real rates to QE announcements, we find that USD19bn of new QE tend to reduce real rates by 1bp. Based on this estimate and on the model dislocation, we find that the 10Y real yield was fully pricing in Operation Twist in September and that since then the dislocation has increased to price in another full QE package, similar in size to QE2, of about USD800bn (excluding reinvestments of maturing agency and MBS holdings).

Here’s the Big Question: Supposing that the high frequency economics releases are right and GDP is growing at a 1-2% rate. Wouldn’t that restrain or delay QE3? (As an aside, star bond manager Jeff Grundlach said during the Q&A after yesterday’s presentation that he doesn’t believe that we will see QE3 between now and the election.)

How will stocks react? Positively because organic growth is rising, or negatively because the Fed won’t be unleashing a tsunami of liquidity that accompanies quantitative easing?

Are the markets already to price in such a scenario? Ed Yardeni wrote that while the Street consensus revenue estimates have been ticking up, earnings estimates have been falling. This sounds like an environment of good news is bad news for the markets and bad news is good news.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.